MPC Stance: Is it moral suasion without authority?

 MPC Stance: Moral Suasion without empowerment?

The Monetary Policy Committee (MPC) of Reserve Bank of India (RBI), ever since the beginning of this FY 2023-24, repeatedly stated its stance as “Remaining focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth". While the repo rate is fixed by MPC, the tools available for implementing the stance, lies with RBI. At least on two occasions, during the current FY, RBI took decisions, which appear to act against MPC’s objectives ‘of bringing inflation to targeted levels and remain focused on withdrawal of accommodation’

Occasion 1. In May 2023, RBI decided to withdraw Rs.2000 bank notes in money circulation (Rs.3.56 lac cr.) with effect from 23rd May 2023. They have to be exchanged in cash for other denomination bank notes or have to be deposited into their accounts by the public in bank branches, including regional offices of RBI, on or before 30.09.23. The banks were advised to sort the deposited notes for accuracy and genuineness and be ready for onward transmission to RBI through the Currency Chest branches of the banks. RBI cited (i) its ‘clean note policy’ (all the notes were issued prior to first half of 2017 and the average life of a bank note is 4-5 years) and (ii) it was observed that the said denomination notes were not commonly used by the public for transactions. With still a month to go, RBI said that, as on 31st August 2023, the public has already remitted Rs.3.32 lac cr. (93% of total 2000 denomination notes in circulation) of which 13% is exchanged as cash for other denominations.  87% of the remittance of the said denominations is for credit to the accounts of customers. This means Rs.43000 cr. of bank notes of other denominations has come fresh into note money circulation among public, ('Rs.2000 denominations were not used by the public commonly for transactions ). Added to the above sum, is Rs.2.89 lac cr. credited into the accounts of the customers, which were either withdrawn by the customers or used by the banks for furthering their credit growth. In effect, Rs.3.32 lac cr. fresh liquidity is pumped into the financial system by the decision of RBI to withdraw the Rs.2000 bank notes in circulation, as by its own admission the said denomination notes were not used commonly by the public for transactions.

Occasion 2. To correct the above anomaly and restrict the continued surplus liquidity, RBI Governor said in his statement (issued after MPC decided to pause the repo rate and continue its monetary stance) on 10th August 2023 that an incremental CRR (I-CRR) of 10% of the increase in demand and time liabilities (DTL) between 19th May 2023 and 28th July 2023, is imposed with effect from the fortnight beginning 12th August 2023. It aimed to impound a little over Rs.1 lac cr. liquidity from the banking system. He also promised to review the I-CRR on 8th September 2023, ahead of the forthcoming festival season. Now RBI has decided to withdraw the I-CRR (in three stages of 25%, 25% and 50%) by 7th October 2023. 

In this regard, the strain on the liquidity with the banks is not yet witnessed. Credit growth Y-o-Y remains at 19%, the average call money rates are well within the repo rate and the responses to the 14-day reverse repo auctions (VRRR) conducted by RBI remain as mute as ever. One fails to understand the rationale behind the latest RBI decision, even when one is eagerly waiting for the CPI inflation figures for August 2023 (July CPI inflation breached 7% by a very good margin).

What is the purpose of the MPC stance, if it is not met by RBI by its actions? How the stated objectives of "inflation progressively aligns with the target" and "remaining focused on withdrawal of accommodation" are achieved by (i) pumping in monies for withdrawal of a denomination, which is not seen used for common transactions by the public' and (ii) withdrawing I-CRR, even while no liquidity crunch is experienced and the bank credit growth remains as robust as ever. 

If someone explains, I am willing to get corrected.

Regards

V.Viswanathan

9th September 2023.


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